Middle East geopolitics - always a market overhang

The Middle East will continue to be a place of supply shock risk for 2014. It is hard to think about oil forecasts without the context of politics. Even if there is better supply from other sources and tepid demand, the market will always have this upside risk unless there is a change in the geopolitical environment. It is hard for the speculative community to get short in size without thinking about this threat. 

Iraq violence is on the rise. This is a situation that is getting worse with a potential break-up of the country as a possible scenario in 2014. It is unlikely for production increases over the longer term because capital will just not be committed. Targets for higher production will not be reached. Current production goals are unlikely to be met. Iraq is the second largest OPEC producer overtaking Iran at more than 2.7 million barrels per day, but this is down from the previous year.  

Iran and the US do not seem like they are moving forward on a nuclear deal. 2013 was a year of positive diplomatic developments but the rhetoric has to be turned into a solution. There is a lot of hard work for any deal, so a disappointment is likely in the first half of 2014. A diplomatic solution will have a negative price shock, but the risk is that optimism will not be rewarded. 

The Syrian situation as not changed. There has been some movement on chemical weapons, but the regime has not met the December 31 deadline for sending chemical weapons out of the country. The real problem is if other Arab countries further intervene in the situation in manner that will expand violence. 

Libyan production has been down big again in 2013. It was bale to produce 1.6 mbpd in 2011 before the revolution but the latest number show production of just over 200,000 bpd. Since the government is so dependent on export revenue, the country will continue to be in a state of anarchy with no funds to stabilize the violence. Major oil players are not going to be investors in this environment.

Of course, the US has made up for a significant part of the shortfall through its strong production gains. Saudi Arabia continues to keep production high, so the market has not tightened significantly. It would be a comfortable forecast that any geopolitical event will not have as strong an effect as what we would have seen before the Great Recession. Still, for leveraged trades, any short-term disruption would be dangerous. The long-term forecast for oil with current significant market backwardation is telling us that the long-run view is that this is not going to be a problem, but given the high level of uncertainty, long dated calls can profit from market complacency.